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The US Phillips Curve and inflation expectations: A State Space Markov-Switching explanatory model

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  • Guillaume Guerrero
  • Nicolas Million

Abstract

This paper proposes a new empirical representation of US inflation expectations in a Stace-Space Markov-Switching framework in order to identify the expectations regimes which are associated with short and long term Phillips curves. We explicitly identify the dynamic of inflation expectation errors using the expectations augmented Markov-switching Phillips curve as a measurement equation. In this paper we consider expected inflation as an underlying component of observed inflation. We thus use the same type of specification (occasionally integrated) to describe its dynamic. We have found that dynamics of inflation expectation errors change across regimes. For the last 20 years we show the Phillips curve is vertical and associated with rational inflation expectations. Whereas for the period of economic instability (1973-1983) a negative Phillips curve is associated with adaptive expectations

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 133.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:133

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Keywords: State-Space Markov-Switching model; Inflation expectation errors; Phillips curve; occasionally integrated process;

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  1. Carlson, John A & Parkin, J Michael, 1975. "Inflation Expectations," Economica, London School of Economics and Political Science, vol. 42(166), pages 123-38, May.
  2. Gordon, Robert J, 1996. "The Time-varying NAIRU and its Implications for Economic Policy," CEPR Discussion Papers 1492, C.E.P.R. Discussion Papers.
  3. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
  4. Sargent, Thomas J, 1969. "Commodity Price Expectations and the Interest Rate," The Quarterly Journal of Economics, MIT Press, vol. 83(1), pages 127-40, February.
  5. Alesina, Alberto, 1988. "Credibility and Policy Convergence in a Two-Party System with Rational Voters," American Economic Review, American Economic Association, vol. 78(4), pages 796-805, September.
  6. Ang, Andrew & Bekaert, Geert, 2002. "Regime Switches in Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 163-82, April.
  7. Paul Mylonas & Sebastian Schich, 1999. "The Use of Financial Market Indicators by Monetary Authorities," OECD Economics Department Working Papers 223, OECD Publishing.
  8. Hasan Bakhshi & Anthony Yates, 1998. "Are UK inflation expectations rational?," Bank of England working papers 81, Bank of England.
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